Back to basics: Buying-to-let

Bricks and mortar might seem an appealing investment, particularly given low returns from savings accounts, but if you’re planning on buying a property to let out, make sure you understand exactly what’s involved.

There are lots of costs involved in becoming a landlord, as well as strict rules on how much you can borrow. We explain all you need to know about buy-to-let….

What’s the difference between a buy-to-let mortgage and a normal mortgage?

Buy-to-let mortgages tend to be arranged on an interest-only basis, rather than a repayment basis where you will pay back both the capital and the interest. They are also generally more expensive than standard - or ‘residential’ mortgages, because the lender is taking on more risk.

There are several reasons a buy-to-let mortgage is considered more risky. For example, if your tenants can’t pay their rent, or you can find anyone to rent your property, you may not be able to afford your repayments. Also, you are not living there yourself and taking personal care and responsibility for the property.

This greater risk also means you will need to put down a bigger deposit than you would if you were buying a property to live in. The usual requirement is at least 25% of the property value, although if you’re an experienced landlord, you may be able to put down 20%.

Where can I find a buy-to-let mortgage?

Many mainstream lenders also offer buy-to-let mortgages but there are also several specialist buy-to-let lenders offering this kind of mortgage. It’s a good idea to compare lots of different deals before choosing a buy-to-let mortgage and to seek advice from a broker if you aren’t certain which deal is best for your individual circumstances.

Can anyone take out a buy-to-let mortgage?

No, you’ll usually need to own your own home, either outright or with a mortgage. Most lenders also require you to have a minimum income, typically around £35,000, not including your rental income, and you’ll usually have to be aged at least 25.

How much can I borrow?

The amount you can borrow through a buy-to-let mortgage is based on the amount of rental income you can expect to achieve. Mortgage lenders will want the estimated rental income to amount to at least a quarter to a third MORE than the interest on your mortgage. That means if your mortgage payments are £750, your rental income should be at least £1,000 or £1,125.

I’ve heard about gearing and buy-to-let – what does that mean?

Gearing is when you borrow money to maximise returns. If, for example, if you only put down a 25% deposit, and the property increases in value by 3% a year, your gains effectively multiply to 12%. This is one of the biggest advantages of buy-to-let investments. However, if property prices fall, then your losses will also be multiplied which could prove financially disastrous.

What sort of yield can I expect from buy-to-let property?

The yield on a buy-to-let property is the returns you can expect from your investment. The gross yield is usually calculated as the annual rent as a percentage of the total value of the property, before any expenses are taken into consideration.

So, for example, if you buy a property for £100,000 and the annual rent you receive is £5,600, the gross yield is 5.6%. The net yield factors in expenses too, so if your operational costs are £500 over the year, you would deduct these from the annual rent to provide a net yield – which would be 5.1% based on the same example.

According to LSL Property Services’ latest buy-to-let index, gross yields on a typical rental property stand at 5.2% as of January 2014, down slightly from 5.3% in January 2013. But of course, yields will vary widely depending on where you are buying, and the sort of property you are investing in. Make sure you do plenty of research before buying so you know what sort of yields to expect.

Where are the best places to buy?

If you want to buy a property to rent out, it’s a good idea to stick to areas you are very familiar with. This will enable you to get a better idea of your target audience and also how likely it is that the property you want to buy will achieve capital growth.

What else should I watch out for?

Is the area you are buying in ‘up and coming’? If there are clear signs of regeneration, such as building renovations and new shops and restaurants, then property values are likely to be on the way up.

Check out whether any new transportation links are on the cards as this means there is investment in the area, and think about existing access to public transport. If the property you are considering buying is miles from any station or bus stop, you will reduce the number of people it is likely to appeal to. Parking is also important, so if possible, buy a property with a designated parking space as this will make it more attractive to potential tenants.

Should I let a property furnished or unfurnished?

That depends on what sort of tenants you are trying to target. According to experts, families often prefer for properties to be unfurnished, while young couples and professional often like properties to be furnished. It pays then to be flexible.

What other costs do I need to think about?

You’ll need to consider everything that is likely to be deducted from your income. For example, if you are buying a flat, there will probably be ground rent and services charges to pay, as well as maintenance costs. You’ll also need to factor in the cost of stamp duty when you buy your property, as well as legal fees.

Don’t forget also to factor in any times when you aren’t able to find a tenant – known as ‘void’ periods. You will need to have contingency funds in place so that you can cover your mortgage when you aren’t receiving any rent.

Do I need a letting agent?

Unless you’ve got lots of time to manage your property on your own, then it is a good idea to take on a lettings agent. They can help you to find tenants and check their references, and they can arrange tenancy agreements on your behalf. They will usually charge around 10% of the monthly rental price for their services, but if you want them to visit the property regularly and collect the rent and pay bills for you, you’ll probably have to pay nearer 15%.

Will I have to pay tax on my rental income?

Yes, you must pay income tax on the rental income, although some of these expenses can be offset. For example, you can offset your mortgage interest as an expense against your rental income and you can also claim 10% against rental income for wear and tear. You cannot, however, claim tax relief on capital repayments or any unnecessary improvements to the property.

If you want to make your buy-to-let property more energy efficient, you may be able to claim a tax deduction of up to £1,500 per property under the Landlord Energy Saving Allowance scheme. Measures covered by the scheme include cavity wall insulation, loft insulation, draught-proofing and hot water system insulation. This allowance is available until April 2015.

Remember than when you sell your property, you’ll have to pay capital gains tax on any increase in value.